Expiration in the financial world of course refers to the finite lifespan of derivatives and futures contracts. The expiration date (and time) refers to the final moment when contracts receive their ultimate settlement value and cease trading.
Expiration is important because traders must make decisions about positions as they get closer to their final settlement value. The last days prior to expiration also involve heightened trading sensitivity because big swings in the broader market can have a significant impact on positions set to expire in a matter of days or hours.
Ignoring positions that are near expiration is of course ill-advised, even if a trader ultimately decides to leave a position on the books. This should be an active decision, not a passive one.
As Tom and Tony point out during the episode, the expiration date for stock options on American exchanges is the third Friday of the trading month. Expiration information of many other traded products is shown below:
Positions that are in-the-money (ITM) are some of the most important because they have the most value. Decisions need to be made on these positions as to whether a trader will close, roll, or choose/take assignment. Likewise, positions that are close to ITM will also need to be monitored carefully.
Trades that are close to ITM are the type that can be most affected by industry or market swings occurring on the final days of the contract's life. Such a swing can create a substantially different scenario for a trader - so all potential rewards and risks should be fully considered for these positions closer to the start of the expiration trading week.
Traders typically build a type of scenario analysis in their mind for different tactics they want to deploy in different positions that are close to ITM.
In practice, this means being aware of market-moving events (Fed decisions, news releases) and constantly filtering your portfolio to ensure you have addressed potential risks. A trader may even deploy bids or offers (not on both sides at the same time) to close positions for reasons of risk or reward.
A common question we receive at tastytrade relates to winning positions and whether a trader should simply let them expire.
In answering this question, Tom and Tony cite previous tastytrade research shown on Market Measures that suggests winning positions should be closed for a profit, and preferably the day before the morning of settlement.
Options that are out-of-the-money (OTM) are worthless and will disappear from your portfolio after expiration. If you are short an option, this is the best case scenario. In this case, a trader may also choose to close these mostly worthless contracts, which can help free up capital.
Going back to ITM options, the chart below shows the ramifications for a trader with one contract of each of the following options positions that are held through expiration:
Obviously, the greater the number of contracts, the greater the risk to the trader of a directional position on the Monday after expiration. A trader that doesn't manage the expiration process properly might end up unconsciously making a directional call on an underlying and ultimately playing a long/short strategy with a position that started off as a volatility play.
The fact that traders need to carefully manage their portfolios around expiration simply can’t be stated enough times. The best investors excel at the entire trade lifecycle - from trade evaluation to trade closing - and a good portion of trade management revolves around expiration decisions.
We hope you will take the time to watch the entire episode of Best Practices featuring the expiration week as well as leveraging the tastytrade “Learn” tab for additional content.
If you have any questions or feedback, please don’t hesitate to contact us at firstname.lastname@example.org
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.